Guyana and the Wider World by Clive Thomas
E-mail address cythomas@guyana.net.gy
In my two previous SN columns I have been evaluating whether it is reasonable to claim that there are positive signs of early recovery from the global economic crisis. Or, whether such a claim is pure political spin. Those who posit signs of early economic recovery rely heavily on gains in the world’s stock exchanges, particularly in the US. They say these indicate renewed investor confidence and an improved business outlook.
I had also referred in those columns to the ‘political spin’ being put on the decline in the reported number of jobs lost in the US for the month of April, compared to March. As I indicated, while April unemployment numbers declined, the US has lost a total of 5.7 million jobs over the previous 16 months of the economic recession. Moreover, its overall unemployment rate (8.9 per cent) remains exceptionally high and ignores the large number of underemployed part-time workers who want to work full-time, but cannot find jobs.
In any event, it is universally accepted that unemployment is a lagging indicator of economic recovery. Reduction in unemployment trails, rather than leads, economic recovery. Right now, the most optimistic forecasts do not see noticeable declines in the US unemployment rate before 2012. This is well after the most pessimistic forecast for economic recovery (2011).
Conditioning circumstances
Two basic conditioning circumstances will largely determine the duration and severity of the global economic crisis. These are: first and foremost, the global dimensions of the crisis, which I shall address in next week’s column. Second, the fact that the epicentre of the crisis is the bursting of the private housing market bubble in the US. Because housing is the principal asset of households this has drastically reduced private consumption, which has been further reduced by income losses due to job losses.
Further, because of the global securitisation of these now toxic mortgage assets, the balance sheets of major financial institutions in the US and around the world have been seriously impaired.
The spectacular collapse and/or government bailout of a number of iconic financial firms like The American Insurance Group (AIG), Bear Stearns, Lehmann Bros, CitiGroup, Goldman Sachs and the Washington Mutual Bank, has not yet been rectified, despite the massive injections from the US Treasury by both the Bush and Obama administrations under the toxic assets relief program (TARP).
Federal Reserve Chairman: ‘Extraordinary times call for extraordinary measures’
By the start of the year, Ben Bernanke, Chairman of the US Federal Reserve System (central bank) had already superintended a significant decline in the target rate for overnight inter-bank loans. This was designed to ease the credit crunch (squeeze). The target rate, which stood at 5.25 per cent in August 2007 had been brought down to a range of 0 and 0.25 per cent by the end of 2008.
The Chairman had declared in early January, 2009: “Weak economic conditions are likely to warrant exceptionally low levels of funds rate for some time.” This action was not therefore undertaken as a short-term measure, but is anticipated to have considerable duration because of the “weak economic conditions.”
Later, on another occasion (February 2009) when he addressed the National Press Club, the Chairman made the famous remark: “Extraordinary times call for extraordinary measures.” As he explained it: “Responding to the very difficult economic and financial challenges we face, the Federal Reserve has gone beyond traditional monetary policy to develop new policy tools to address the dysfunctions in the nation’s credit markets.”
Traditionally, the Federal Reserve has pursued minimal intervention into the operations of the US economic and financial system. The Federal Reserve relied on demand and supply behaviour in private markets to resolve emerging imbalances in the US economy. It was the rule that Federal Reserve intervention distorted prices, costs, and therefore profit outcomes in private financial markets. Consequently, it was injurious to the system.
New tools
What are the “new tools” introduced by the Federal Reserve to get around the “dysfunctions” or “blockages” in the monetary transmission mechanism? The Federal Reserve traditionally operated through changes in the supply of money and/or the price of credit (interest rate). The new tools however 1) provide direct liquidity to borrowers in key credit markets 2) do the same for selected investors 3) purchase highly rated 3 month commercial paper 4) provide back-up liquidity for money market mutual funds and 5) establish funding for a Term Asset Backed Securities Loan Funding program (TALF).
Stress test for banks
Later, the US authorities designed stress tests for the 19 biggest banks in order to see how they would cope with severe systemic disorder. The concern behind this is that the largest banks are considered as too big to fail. That is, if any of them failed this would threaten not only the collapse of the entire US financial system, but in all likelihood that of the entire global system.
The results of these stress tests indicate some improvement in the present situation when compared to the last quarter of 2008. However, a majority of the banks needed further capital injections if they are to cope with a serious systemic breakdown of the US real economy.
Focus
So far I have focused on performance of the US economy, in assessing whether it is reasonable to assume that we are near the end of the global economic crisis. The reason for this is the US is not only the largest global economy, but its impact on global growth and trade is overwhelming,
Four decades ago, the statement was commonplace that when the US economy sneezes, the rest of the world catches a cold, or worse, pneumonia. At that time the share of external trade to its GDP was 10 per cent. Today, the US economy is far more open. The share of external trade to GDP has trebled, to 30 per cent. Every major grouping of the global economy is closely interlocked into the growth, trade and investment outcomes of the US economy. This is true for the other rich industrialised G8 countries, the major emerging markets of Brazil, India and China, as well as the varied assortment of poor developing countries.
Next week I shall begin to address the global aspects of the crisis emphasising the developing countries, to see whether reliable signs of economic recovery can be found.
